Level 6 · Financial Ratios
Liquidity Ratios
Can the company pay the bills that land in the next twelve months?
In this lesson
What you'll be able to do
- Calculate current and quick ratios
- Explain what each excludes
- Recognise sector differences
- Spot liquidity stress early
Think about it
A profitable company with valuable land was forced into insolvency. What did it run out of?
Story
Let's picture it
A jeweller has ₹5 crore of gold stock and a beautiful showroom, but only ₹4 lakh in the bank. A ₹40 lakh payment falls due next week. The wealth exists, but it is locked inside display cases that cannot be sold overnight at full price. Solvency and liquidity are different problems.
Visual
Two liquidity checks
Current ratio
Current assets ÷ Current liabilities
Quick ratio
Same, but excluding inventory, the hardest asset to convert
Compare
A big gap between the two means inventory dominates current assets
Interpret in context
Retailers, manufacturers and services carry very different norms
Plain English
The simple explanation
The current ratio compares assets expected to convert to cash within a year against liabilities due within a year. Roughly 1.5 to 2 is often described as comfortable in many sectors.
The quick ratio excludes inventory, because unsold stock is the current asset least likely to turn into cash quickly at full value.
A ratio that is too high is not automatically good, it can mean cash sitting idle, or receivables and inventory piling up. Read liquidity alongside working capital trends.
Real world
Organised retail
Retailers often operate with low current ratios because they sell inventory for cash quickly while paying suppliers on credit. The same ratio at a heavy engineering firm with long production cycles would signal real stress.
Watch out
Common mistakes
- Applying one benchmark to every sector.
- Ignoring the inventory component.
- Reading a single year instead of the trend.
Did you know?
Working capital management is often the difference between a profitable small business surviving and closing, cash timing, not profitability, is the usual cause of failure.
Your turn
Mini challenge
Calculate the current and quick ratios for one company. How much of the gap is inventory?
Quick quiz
1 / 5
Wrap up
Summary
Current and quick ratios test whether near-term obligations can be met. Read them by sector, watch the inventory component, and treat the trend as more informative than the level.
- Current ratio includes inventory; quick ratio doesn't
- Sector norms vary widely
- Very high can be as telling as very low
- Liquidity failures kill profitable companies
Revise